Warren Buffett Total Stock Market Value to GNP Ratio Strategy

This strategy is a market timing strategy based on Warren Buffett's valuation metric ratio of total US stock market capitalization to GNP.

In his 2001 Fortune magazine article, Warren Buffett used the ratio of the market value of all US publically traded securities to Gross National Product (GNP) as a yardstick to measure the stock market valuation. He stated that  

"The ratio has certain limitations in telling you what you need to know. Still, it is probably the best single measure of where valuations stand at any given moment".

He further went on to say

"If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you. If the ratio approaches 200%--as it did in 1999 and a part of 2000--you are playing with fire".

Such a simple yet elegant metric could be implemented in several ways. This strategy characterizes the valuation into the following five categories:

  • Significantly Overvalued (SO): such as if the ratio >= 115% .
  • Modestly Overvalued (MO): such as if   90% <=  ratio < 115% .
  • Fairly Valued (FV): such as if 75% <= ratio < 90% .
  • Modestly Undervalued (MU): such as if 50% <= ratio < 75% .
  • Significantly Undervalued (SU): such as if ratio < 50%.

These five categories are determined by four valuation parameters (such as 115%, 90%, 75% and 50% in the above). At each rebalancing (adjusting) period (such as weekly or monthly), the strategy decides at what category the US stock market valuation is and then does the following rebalancing:

  • SO: 0% in stock, 100% in cash.
  • MO: 25% in stock, 75% in cash.
  • FV: 50% in stock, 50% in cash.
  • MU: 75% in stock, 25% in cash.
  • SU: 100% in stock, 0% in cash.

Users could adjust the valuation parameters to get an effect such as only buying at significantly undervalued (SU) level and selling at significantly overvalued (SO) level. Some of model portfolios of this strategy are:

  • SO: >=115%, MO: [90%, 115%), FV: [75%, 90%), MU: [50%, 75%), SU: <50% .
  • SO: >=115%, MO, FV, MU: [50%, 115%), SU: <50% .


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